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Lahore School of Economics MBA 1 (2019)

Pure Competition
Dr Ayesha Afzal
Assistant Professor
Lahore School of Economics MBA 1 (2019)

Four Market Models


• Pure Competition
• Pure Monopoly
• Monopolistic Competition
• Oligopoly
Imperfect Competition
Pure Monopolistic Pure
Competition Competition Oligopoly Monopoly

Market Structure Continuum


Lahore School of Economics MBA 1 (2019)

Pure Competition
• Very Large Numbers
• Standardized Product
• “Price Takers”
• Free Entry and Exit
• Perfectly Elastic Demand
–Average Revenue
–Total Revenue
–Marginal Revenue
Graphically…
Lahore School of Economics MBA 1 (2019)

$1179
Firm’s Firm’s TR
Demand Revenue 1048
Schedule Data
(Average
Revenue) 917
P QD TR MR

Price and Revenue


786
$131 0 $0
] $131 655
131 1 131
] 131
131 2 262
] 131
131 3 393 524
] 131
131 4 524
] 131
131 5 655 393
] 131
131 6 786
] 131 262
131 7 917
] 131 D = MR = AR
131 8 1048
131 9 1179
] 131 131
131 10 1310 ] 131
2 4 6 8 10 12
Quantity Demanded (Sold)
Lahore School of Economics MBA 1 (2019)

Profit Maximization in the Short


Run
Total Revenue-Total Cost Approach

Consider:
–Should Product Be Produced?
–If So, In What Amount?
–What Economic Profit (Loss)
Will Be Realized?
Lahore School of Economics MBA 1 (2019)

Total Revenue-Total Cost Approach


Price = $131
(1) (2) (3) (4) (5) (6)
Total Product Total Fixed Total Variable Total Cost Total Revenue Profit (+)
(Output) (Q) Cost (TFC) Cost (TVC) (TC) (TR) or Loss (-)

0 $100 $0 $100 $0 $-100


1 100 90 190 131 -59
2 100 170 270 262 -8
3 100 240 340 393 +53
4 100 300 400 524 +124
5 100 370 470 655 +185
6 100 450 550 786 +236
7 100 540 640 917 +277
8 100 650 750 1048 +298
9 100 780 880 1179 +299
10 100 930 1030 1310 +280
Do You
Now ’s Graph
See
Let The Results…
Profit Maximization?
Lahore School of Economics MBA 1 (2019)

Total Revenue-Total Cost Approach $1800


1700 Break-Even Point
1600 (Normal Profit)

Total Revenue and Total Cost


1500
1400 Total Revenue, (TR)
1300
1200
1100 Maximum
1000 Economic
Total Cost,
900 Profit
800 $299 (TC)
700
600
500 P=$131
400
300 Break-Even Point
200 (Normal Profit)
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Total Economic

Quantity Demanded (Sold)


$500
Total Economic $299
Profit

400
300 Profit
200
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)
Lahore School of Economics MBA 1 (2019)

Marginal Revenue-Marginal Cost Approach


MR = MC Rule
Important Features:
• Firm Will Shut Down
Unless MR at Least
Meets MC
• Profit Maximization in All
Market Structures
• Can Be Restated P = MC
Lahore School of Economics MBA 1 (2019)

Marginal Revenue-Marginal Cost Approach


MR = MC Rule
(2) (3) (4)
(1) Average Average Average (5) (6)
Total Fixed Variable Total Marginal Marginal (7)
Product Cost Cost Cost Cost Revenue Profit (+)
(Output) (AFC) (AVC) (ATC) (MC) (MR) or Loss (-)

0 $-100
1 $100.00 $90.00 $190.00 $90 $131 -59
2 50.00 85.00 135.00 80 131 -8
3 33.33 80.00 113.33 70 131 +53
4 25.00 75.00 100.00 60 131 +124
5 20.00 74.00 94.00 70 131 +185
6 16.67 75.00 91.67 80 131 +236
7 14.29 77.14 91.43 90 131 +277
8 12.50 81.25 93.75 110 131 +298
9 11.11 86.67 97.78 130 131 +299
10 10.00 93.00 103.00 150 131 +280
DoNo
You See Profit
Surprise Let’s GraphNow?
Maximization
- Now It…
Lahore School of Economics MBA 1 (2019)

Marginal Revenue-Marginal Cost Approach


MR = MC Rule
$200

P=$131 MR = MC
Cost and Revenue

150 MC

Economic Profit MR = P
ATC
100
AVC
A=$97.78

50

0
1 2 3 4 5 6 7 8 9 10
Output
Lahore School of Economics MBA 1 (2019)

Marginal Revenue-Marginal Cost Approach


MR = MC Rule
Loss Minimizing Case
$200

Lower the Price to $81 and


Observe the Results!
Cost and Revenue

150 MC

Loss
A=$91.67
ATC
100 AVC
MR = P
P=$81

V = $75
50

0
1 2 3 4 5 6 7 8 9 10
Output
Lahore School of Economics MBA 1 (2019)

Marginal Revenue-Marginal Cost Approach


MR = MC Rule
Short-Run Shut Down Case
$200

Lower the Price Further to


$71 and Observe the Results!
Cost and Revenue

150 MC

ATC
V = $74
100 AVC

MR = P
P=$71
50 Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74
0
1 2 3 4 5 6 7 8 9 10
Output
Lahore School of Economics
Marginal Cost and Short- MBA 1 (2019)

Run Supply
Continuing the Same Numeric
Example…
Supply Schedule of a Competitive Firm
Quantity Maximum Profit (+)
Price Supplied or Minimum Loss (-)
$151 10 $+480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
71 0 -100
61 0 -100
The Schedule Shows the Quantity a Firm
Will Produce at a Variety of Prices and Results
Lahore School of Economics
Marginal Cost and Short- MBA 1 (2019)

Run Supply
Generalizing the MR=MC
Relationship and its Use
Cost and Revenues (Dollars)

MC
e
P5 MR5
d
ATC
P4 MR4
c AVC
P3 MR3
b
P2 MR2
a
P1 MR1

This Price is Below AVC


And Will Not Be Produced

0 Q2 Q3 Q4 Q5
Quantity Supplied
Lahore School of Economics
Marginal Cost and Short- MBA 1 (2019)

Run Supply
Generalizing the MR=MC
Relationship and its Use
Examine the MC for the Competitive Firm
MC Above AVC Becomes
Cost and Revenues (Dollars)

the Short-Run Supply Curve S


Break-even MC
(Normal Profit) Point e
P5 MR5
d
ATC
P4 MR4
c AVC
P3 MR3
b
P2 MR2
a
P1 MR1

Shut-Down Point
This Price is Below AVC (If P is Below)
And Will Not Be Produced

0 Q2 Q3 Q4 Q5
Quantity Supplied
Lahore School of Economics MBA 1 (2019)

Changes in Supply
• Firm and Industry
–Equilibrium Price
–Market Price and Profits
–Firm Versus Industry
Graphically…
Lahore School of Economics MBA 1 (2019)

Changes in Supply
Single Firm Industry
p P
S = ∑ MC’s

s = MC

Economic
Profit ATC
d $111
$111
AVC

0 8 p 0 8000 P

Competitive Firm Must Take the Price that is


Established By Industry Supply and Demand
Profit Maximization in the
Lahore School of Economics MBA 1 (2019)

Long Run
• Assumptions
–Entry and Exit Only
–Identical Costs
–Constant-Cost Industry
• Goal of the Analysis
• Long-Run Equilibrium
–Entry Eliminates Profits
–Exit Eliminates Losses
Lahore School of Economics MBA 1 (2019)

Supply Readjustment
Single Firm Industry
p P
S1

MC

ATC S2
$60 $60

50 50
MR
D2
40 40

D1

0 100 p 0 80,000 90,000 100,000 P


An Increase in Demand Temporarily Raises Price
Higher Prices Draw in New Competitors
Increased Supply Returns Price to Equilibrium
Lahore School of Economics MBA 1 (2019)

Supply Readjustment
Single Firm Industry
p P
S3

MC

ATC S1
$60 $60

50 50
MR
D1
40 40

D3

0 100 p 0 80,000 90,000 100,000 P

A Decrease in Demand Temporarily Lowers Price


Lower Prices Drive Away Some Competitors
Decreased Supply Returns Price to Equilibrium
Lahore School of Economics MBA 1 (2019)

Long-Run Supply Curve


Constant-Cost Industry
P

P1
P2 $50 S
Z3 Z1 Z2
P3

D3 D1 D2

0 Q3 Q1 Q2 Q
90,000 100,000 110,000
Lahore School of Economics MBA 1 (2019)

Long-Run Supply Curve


Increasing-Cost Industry
P

S
P2 $55
Y2
P1 $50
Y1
P3 $40
Y3
D2

D1
D3
0 Q3 Q1 Q2 Q
90,000 100,000 110,000

How Would a Decreasing-Cost Industry Look?


Lahore School of Economics
Pure Competition and
MBA 1 (2019)

Efficiency
• Productive Efficiency
P = Minimum ATC
• Allocative Efficiency
P = MC
• Maximum Consumer and
Producer Surplus
• Dynamic Adjustments
• “Invisible Hand” Revisited
Lahore School of Economics MBA 1 (2019)

Long-Run Equilibrium
Competitive Firm and Market
Single Firm Market
P=MC=Minimum MC S
ATC (Normal Profit)
ATC

Price
Price

P MR P

D
0 Qf 0 Qe
Quantity Quantity
Productive Efficiency: Price = Minimum ATC
Allocative Efficiency: Price = MC
Pure Competition Has Both in
Its Long-Run Equilibrium